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Equipment check
Chip-equipment stocks like Applied Materials are on fire. How much longer could the rally last?
November 12, 2003: 9:18 AM EST
By Paul R. La Monica, CNN/Money Senior Writer

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NEW YORK (CNN/Money) - If you thought chip makers like Intel and Texas Instruments were having a strong 2003, well, to quote Bachman Turner Overdrive, you ain't seen nothing yet.

Chip equipment companies -- Applied Materials, KLA-Tencor, Lam Research and others -- are really taking care of business. (Sorry, couldn't resist)

The average stock price gain this year for the 29 chip-equipment companies with a market value of at least $500 million is a stunning 116 percent, according to Thomson/Baseline.

Shares of industry leader Applied Materials (AMAT: Research, Estimates), which reports its fiscal fourth-quarter earnings on Wednesday, are up 87 percent year-to-date.

Why are these stocks doing so well? Investors are hoping that as semiconductor demand improves, big chip companies like Intel will start boosting orders for production equipment.

Sales for the 29 chip-equipment firms are expected to increase 25 percent, on average, next year, while analysts are predicting an earnings surge of 229 percent.

All eyes on AMAT

That's the theory. Will it actually happen? Investors should get some answers Wednesday when Applied Materials, usually referred to on Wall Street by its ticker symbol, AMAT, reports.

AMAT is the largest chip-equipment company, so its results are scrutinized for signs of improving demand.

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Company Price change YTD P/E* Est. EPS Growth* 
Applied Materials 87.3% 53.1 254% 
KLA-Tencor 64.5% 63.9 36% 
Novellus Systems 50.8% 59.6 238% 
Teradyne 83.1% 49.6 181% 
Lam Research 178.8% 94.1 256% 
 * based on fiscal '04 estimates as of 11/10/03
 Source:  Thomson/Baseline

Analysts expect AMAT to post earnings of 5 cents per share for the quarter, down from 9 cents a year ago. The consensus sales estimate is $1.14 billion, compared with $1.45 billion in the same period last year.

Doesn't sound like a great quarter, but this should represent the worst of it for AMAT and other equipment makers. Wall Street will really turn its steely gaze (not to be confused with BTO contemporaries Steely Dan) to what AMAT has to say about its new-order growth.

New orders are a key indicator of future sales for chip-equipment companies. AMAT reported new orders of $1.05 billion in its fiscal third quarter and told Wall Street that new orders should be about 10 percent higher in the fourth quarter. So Wall Street will be expecting, at a bare minimum, new orders of about $1.15 billion.

But is this growth already priced into the stock? Expectations are high and AMAT will probably have to deliver stupendous guidance for its stock, and the rest of the sector, to keep heading higher.

New orders need to surge to justify runup

Along those lines, Suresh Balaraman, an analyst with ThinkEquity Partners, said he's expecting AMAT to report new orders of between $1.2 billion and $1.3 billion for the fourth quarter and that the company will give guidance of about $1.3 billion to $1.5 billion for the first quarter.

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But he said that probably wouldn't be enough to satisfy investors.

"For the stock to have any more near-term upside, AMAT needs to go north of $1.5 billion," Balaraman said.

And for AMAT to live up to lofty expectations, there will need to be some more signs from leading chip companies that they are willing to spend more on capital spending next year.

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Intel hasn't given any indication that it will. But it may be the exception, said Vijay Rakesh, an analyst with Berean Capital, an independent research firm.

Rakesh said chip companies in Asia, particularly Samsung, Taiwan Semiconductor and United Micro Electronics, should spend significantly more next year to keep up with burgeoning demand for chips used in flat-panel TV screens and computer monitors.

Nonetheless, the big moves in major chip-equipment stocks should be a bit of a concern. The 29 chip-equipment stocks I've mentioned trade at an average of 61 times fiscal 2004 earnings estimates. "Valuations are pretty expensive," concedes Rakesh.

And investors have learned the hard way how easy it can be for pricey momentum stocks to get derailed. Any slight hiccup in AMAT's earnings report could be a good excuse for a pullback.

Analysts quoted in this story do not own shares of AMAT and their firms have no investment banking relationships with the company.


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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.